VIX Jumps, but Volume Shows Complacency

The market’s so-called fear gauge jumped to its highest intraday level since June 25 early Monday, underscoring worry that the debt-ceiling fight will go down to the wire or beyond. But low volume suggests many investors are still sitting on their hands.

The Chicago Board Options Exchange 's Volatility Index jumped 13% to as high as 18.93 at the open of trading, before easing slightly. The index was recently up 1.64 points, or 9.8%, at 18.38. At the open, the VIX reached the highest level since worry surfaced in June about the Federal Reserve pulling back from its accommodative policies.

But a lack of real turbulence in the market in recent weeks as led to a large gap between expected volatility and what has been seen of late. That leaves an “unsustainable” environment, according to Jim Strugger, derivatives strategist at equity research and trading firm MKM Partners. “Actual market violence and turbulence hasn’t gone anywhere,” he said.

The current reading on the VIX, a measure of expected volatility over the coming 30 days, stood about nine points above historical volatility, a measure of actual market swings over the prior month. That gap is the largest since late last year, as Congress neared its deadline to reach a budget agreement to avert the year-end tax increases and spending cuts known as the fiscal cliff.

That gap must resolve itself, either with more violent stock swings, or a resolution in Washington that brings the VIX lower, according to Mr. Strugger. “We haven’t had a violent pullback, and you have to wonder, does the government need violence in financial markets as the trigger to act,” Mr. Strugger said.

The government shutdown is entering its second week, with few signs of progress. And House Speaker John Boehner this weekend said he would link bills on the federal budget, which would allow the government to reopen, to debate on the country’s borrowing limit.

The VIX is calculated from the prices investors are willing to pay for options tied to the S&P 500. The index typically moves inversely to stocks, because a drop in stocks usually sparks buying of options looking to protect against–or profit from–heightened price swings.

Trading volume in those options tied to the S&P 500 was light Monday. About 483,000 contracts are projected to trade through the end of the day, according to Trade Alert LLC data. That is 42% below the average over the past month, according to the data. Trading in VIX options was also running below average. Typically, volume spikes when investors fear a drop in stocks, as such options can be used to hedge stock portfolios.

“Each time we go through a situation of this nature and the world doesn’t come to an end, investors become a little more sanguine and think there is less of a need to hedge,” said Steve Sosnick, an equity risk manager at Timber Hill, the market-making unit of Interactive Brokers Group Inc.

“You’ve got the mark up in the VIX without the volume, because there is faith that something somewhere is going to make Congress wake up and get stuff done,” said Mr. Sosnick. “I don’t know where they get that faith, but it’s there.”

And that lack of hedging leaves stocks vulnerable to big moves if a severe drop does occur.

“If you’re under hedged, when dislocation does happen, you’re really left to scramble,” said MKM’s Mr. Strugger.